Mar
2023
Investing Basics: The Management Sniff Test
DIY Investor
6 March 2023
The biggest risk a business faces is having bad management. That’s according to Warren Buffett in his latest shareholder meeting – writes the Undercover Fund Manager
I agree. Assessing company management is one of the most important jobs an investor faces, but it’s far from easy and is more an art than a science.
Buffett’s business partner, Charlie Munger, famously says, “All I want to know is where I’m going to die, so I’ll never go there”. I tend to approach the challenge of assessing company management in a similar way.
Below, I outline (in no particular order) a series of red flags that serve as warning signals for me. Some of these are very common and won’t necessarily put me off from investing in a company, but a combination would be a potential cause for concern.
Red flags to watch out for
- Excessive focus on factors outside of management’s control, such as quarterly profit and share price, as opposed to things like customer and employee satisfaction.
- Excessive optimism, combined with a tendency to over-promise and under-deliver. Words not backed up with actions.
- Excessive focus on growth with little mention of returns.
- Evasive, often failing to answer the question asked.
- Highly promotional – more interest in selling a story than explaining the business.
- Favour jargon and obfuscation, seemingly incapable of explaining things simply.
- A willingness to issue short-, mid- and long-term ‘guidance’, combined with an eagerness to cut costs to meet said guidance.
- Poor attention to detail, evidenced by ‘woolly’ statements not backed up with data, a lack of suitable key performance indicators, etc.
- Lack of clarity/muddled thinking in verbal and written communications.
- Lack of candour combined with an unwillingness to admit mistakes.
- Unwillingness to discuss areas for improvement, even when questioned.
- Regularly blame poor results on external circumstances, eg, weather.
- A short-term business outlook.
- A poor understanding of where the company’s competitive advantages lie.
- A lack of focus, evidenced by questionable diversification efforts or unwillingness to consider asset disposals, for example.
- A lack of independent thought.
- Hiding or withholding important information.
- Liberal use of exceptional items, regular accounting changes and other signs of financial jiggery, combined with a focus on adjusted metrics (eg, adjusted EBITDA).
- Aggressive accounting relative to peers.
- Constant restructuring and changes in business strategy.
- Constantly moving targets, changing divisional reporting structures, etc, making it hard to track progress.
- Excessive time spent on investor relations.
- CEO flashy, arrogant, over-confident and/or a control freak (eg, not letting CFO get a word in edgeways).
- Defensive manner, especially in response to difficult questions.
- Complacent, constantly downplaying genuine risks and threats to the business.
- Excessive reliance on equity issuance to fund growth projects with questionable returns.
- Excessive remuneration, inappropriately structured (eg, one-year share price/profit performance) combined with low director share ownership.
- Excessive use of debt/leverage.
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